Read the dialogue between David and Leona in Section 2.12. What errors can occur in reporting the amount of ‘inventories’ (stocks) in financial statements?

Data from Section 2.12

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DAVID: I've now coated your ceiling with apple green emulsion. In return you promised to convince me that I rely on audited accounting information more than I realise. Here is your chance to do that. I was looking today at the annual report of a company which is a manufacturing business. There is a production centre in the UK but most of the production work is carried out in Spain where the operating costs are lower. The distribution operation is carried out from Swindon, selling to retail stores all over the UK. There is an export market, mainly in France, but the company has only scratched the surface of that market. Let's start with something easy - the inventories (stocks) of finished goods which are held at the factory in Spain and the distribution depot in Swindon. LEONA: You've shown right away how limited your understanding is, by choosing the asset where you need the auditor's help the most. Everything can go wrong with inventories (stocks)! Think of the accounting equation: Assets - Liabilities = Ownership interest If an asset is overstated, the ownership interest will be overstated. That means the profit for the period, as reported, is higher than it should be. But you won't know that because everything will appear to be in order from the accounts. You have told me repeatedly that you buy the future, not the past, but I know you look to the current profit and loss account as an indicator of future trends of profit. And so do all your friends. DAVID: How can the asset of finished goods inventories be overstated? It's quite a solid item.